Financial Update (April-June 2001)


Cover Story

Subprime Lending Guidance

Economics of Checks

Greenspan on Lending

Retail Banking Fees

ATM Fee Disclosure


Did You Know?

Data Bank

The Docket


Fed’s Supervision Duties Face Challenges as Banking Evolves

Bank examiner —for some people, those words conjure an image of the mousy, bespectacled man waiting impatiently in George Bailey’s office in Frank Capra’s classic movie “It’s a Wonderful Life.”

The bank examiner’s Christmas Eve visit to Bailey’s Building and Loan sends George into a panic because his absent-minded Uncle Billy has lost the family firm’s daily bank deposit. George anguishes over the thought that the bank examiner can call down the law to send George to prison, leaving his family disgraced and destitute.

Hollywood often distorts reality to tell a good story, and Capra’s milk-toast but menacing bank examiner sets a pivotal story line in motion. But the movie’s bank examiner certainly doesn’t resemble the real-life ones, even those in 1946, when the movie debuted.

Rewind to 1913, when (in real life) the Federal Reserve System was established by Congress. One of the Fed’s primary mandates was to foster a safer, more stable banking system. Through its authority to regulate and supervise certain types of banking organizations and activities, the Federal Reserve has, over the decades since 1913, helped to forestall a number of financial crises and to manage crises once they occur.

The Federal Reserve’s supervision of banks is carried out mostly by Federal Reserve Bank examiners, whose real-life roles are constantly being rewritten as the financial industry improvises new plot twists.

Doing its duty

Fast-forward to 2001. Today’s U.S. financial system is complex, governed by a wide variety of federal and state laws and with many different kinds of organizations under numerous chartering authorities.

Banking institutions are supervised by a number of different federal, state, and foreign banking agencies. Federal agencies are the Federal Reserve, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corp. (FDIC), and the Office of Thrift Supervision (OTS). Because many financial institutions and activities fall under the jurisdiction of more than one regulator, these agencies often coordinate their supervisory efforts.

The Fed has primary authority for supervising

  • all bank holding companies, including their nonbank and foreign subsidiaries;
  • state-chartered banks that are members of the Federal Reserve System, along with their foreign branches and subsidiaries; and
  • Edge Act corporations (international banking organizations chartered by the Federal Reserve Board, usually subsidiaries of member banks), through which banking organizations conduct international transactions.

The Fed also shares responsibilities with state supervisors and other federal supervisors for overseeing the operations of foreign banking organizations in the United States.

Other Fed supervisory duties include monitoring banks’ compliance with consumer protection laws relating to credit, with legislation concerning community reinvestment and with the money-laundering provisions of the Bank Secrecy Act.

Under the Gramm-Leach-Bliley Act, signed into law in November 1999, the Federal Reserve became the umbrella supervisor of a new type of organization, financial holding companies.

Domestic interests

Bank supervision involves monitoring, inspecting and examining banking organizations to assess their condition and their compliance with relevant laws and regulations.

In years past, examiners monitored banks mainly through on-site visits. But as the world has become more and more computerized over the past few decades, examiners have come to rely mostly on off-site monitoring.

Examiners review reports of recent examinations and inspections, information published in the financial press and elsewhere and, most important, the standard financial regulatory reports filed by institutions. The number and type of report forms that an institution must file depend on the institution’s size, the scope of its operations and the types of financial entities it includes.

Automated screening systems help examiners identify organizations with poor or deteriorating financial profiles and detect adverse trends in the banking industry. One such system statistically estimates an institution’s supervisory rating based on information that institutions provide in the quarterly reports required by regulation.

When these analytical tools indicate that an organization has problems, the supervising Reserve Bank develops a plan for correcting the problems, a plan that may include sending examiners to the institution.

During an on-site examination of a state member bank or an inspection of a bank holding company and its subsidiaries, Reserve Bank staff look at a wide range of information. Typically, they evaluate the soundness of an institution’s assets and the effectiveness of its internal operations, policies and management, especially as these relate to risk management. Examiners analyze key financial factors such as the institution’s capital, earnings, liquidity and sensitivity to interest rate risk; assess the institution’s exposure to off-balance-sheet risks; and determine the institution’s overall soundness and solvency. In addition, examiners check for compliance with banking laws and regulations.

On-site examinations and inspections are still an important part of the Fed’s supervision, so on-site visits occur periodically for all institutions, not just the troubled ones.

Watchdogging consumer and community interests

Specially trained Fed staff examine banks to ensure that they comply with consumer protection laws related to credit, including transactions involving charge and credit cards from financial institutions and retail establishments, automated teller machines, deposit accounts, automobile leases and mortgages.

The examiners review banks’ policies and procedures, consumer files and other financial documents to make sure that banks’ disclosures on such matters are reported accurately and in a timely manner and that banks have dedicated enough resources to ensure compliance.

The Fed responds to public inquiries and complaints about consumer credit protection issues. It investigates complaints about state member banks and refers other complaints to the appropriate regulator.

Examiners also review a bank’s efforts to comply with the Community Reinvestment Act, which requires banks to meet the credit needs of their entire market, including low- and moderate-income neighborhoods.

Global scope

In addition, the Federal Reserve is responsible for supervising the foreign operations of state member banks and U.S. bank holding companies.

By law, U.S. banks operating abroad may engage in a broader range of financial activities than banks operating in the United States. The Fed works with the supervisory authorities of other countries to develop supervision policies that allow U.S. banks to compete fairly with host country institutions.

For foreign banking organizations, the Federal Reserve supervises their U.S. branches; agencies; representative offices; and bank, commercial lending and nonbank subsidiaries. Foreign banks operating in the United States must adhere to the same banking laws that apply to U.S. domestic banks.

Under the umbrella

The Gramm-Leach-Bliley Act authorizes bank holding companies to become financial holding companies (FHCs), which may engage in, or have affiliates that engage in, securities underwriting and dealing, insurance agency and underwriting activities, merchant banking and other types of financial activities.

The act makes the Federal Reserve the umbrella supervisor of FHCs. By law, the Fed must rely, for the most part, on publicly available information, external audit statements, and reports the companies or their subsidiaries must provide to other supervisory authorities. The Fed’s review of FHCs focuses on risk profiles and consolidated managerial strength with particular attention to whether any weaknesses might adversely affect the insured depository institutions.

New horizons

The days when banks supervision relied mainly on examiners traveling to banks are only distant memories. Today, bank supervision relies more on laptops than on ledgers. Banking institutions can now offer more diverse types of products than ever before, and the challenge to supervisory agencies like the Federal Reserve comes not from having examiners log travel miles but in keeping staff trained to stay abreast of technological and regulatory changes.

Banks also are no longer corralled by state or national boundaries, so the Fed’s partnerships with other federal supervisors and state and foreign agencies will become even more critical.